Employment Externalisation in Response to a Temporary Exogenous Shock: An Adjustment Costs Perspective

We examine the externalisation of labour as a strategic response to a temporary exogenous shock (i.e. COVID-19). Combining ideas from employment externalisation theory and the CATO framework (which are both extensions of transaction costs economics), we argue that firms that are hit harder by the COVID-19 shock are more likely to plan hiring freelancers that replace permanent employees. The mechanism we argue for is that firms seek to reposition quickly, which lowers comparative adjustment costs and reduces constraints on switching employment modes in future, depending on the extent of task co-specialisation. Analysing survey data obtained from 1,090 Danish small medium enterprises during the initial COVID-19 lockdown supports our hypotheses. Our findings contribute to the research on strategic responses to crises and provide novel understanding of why firms may externalise employment.